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When my wife and I purchased our home my in laws lent us about $80k. We set up a fair interest rate and we've been making our monthly payments to them as agreed. We have every intention of paying them back, and they expect us too as well.

My father in law is paying taxes on the interest he's earning from us and he told us that we can claim the home mortgage interest deduction. I checked into it a bit and it's my understanding that I cannot, that we need to be issued a Form 1098 from our lender (him).

Can I take the home mortgage interest deduction? As a side question, should my father in law be paying taxes on the interest of our loan (in other words does he need to find a better tax guy)?

Edit
The money they lent us went towards our down payment. As I recall the bank wanted (and received) a letter, signed by us and my in-laws saying we do not have to repay the loan. However - like I said above - my wife are repaying the loan per our private agreement. There's no documentation for this agreement however.

  • Is it really a mortgage? I.e.: is the loan secured by the property and properly recorded? – littleadv Mar 19 '12 at 23:26
  • @littleadv I added something I should not have left out. The loan is not recorded and is a private agreement only. – user5990 Mar 19 '12 at 23:54
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    Then its not a mortgage and you cannot deduct the interest. – littleadv Mar 20 '12 at 0:04
  • You are going to want to be extremely careful here, as both you and your wife, as well as your in-laws, appear to have committed fraud. – ChrisInEdmonton Mar 20 '12 at 15:58
  • Chris - fraud against whom? The bank can request a paper trail of funds and seems to have done just that. They counciled the buyer to get the letter from him parents when they knew it wasn't a gift, but a loan. First, jail all the bankers. – JoeTaxpayer Mar 21 '12 at 1:47
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For this type of loan, to be considered "arm's length," the rate needs to be fair (you got that covered), the loan must be secured against the house, via a lien, else it may be considered a non-deductible personal loan, and last, you need the 1099. You might get away with the first 2, as he's claiming the interest, but the lien is key.

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